At 1245 BST/ 0745 ET this Wednesday the ECB will announce its latest policy decision followed by a press conference held by ECB President Mario Draghi. All economists polled by Bloomberg expect the ECB to remain on hold when it meets this week, which leaves the Draghi press conference as a potential market mover.
Draghi: a careful balancing act
We expect Draghi to sound cautiously optimistic during his press conference as there have been signs of green shoots in the Eurozone economy. Better than expected data included:
- Manufacturing PMI.
- An improvement in headline inflation.
- A stronger PPI reading for Feb, which bodes well for future CPI.
- A pick-up in industrial, consumer, and economic confidence.
- A strong trade balance in Germany.
- Some better than expected industrial data in Italy, suggesting that this beleaguered economy could be turning a corner.
This is why the Eurozone’s economic surprise index, as measured by Citigroup, is close to its highest level in 3 years. However, Draghi may not want to sound too optimistic as some ECB members are suggesting that the ECB’s QE programme could be cut short if we continue to see a pick-up in the economic data.
We believe that Draghi will want to dampen speculation that the ECB’s QE programme, which started purchasing assets only last month, could be terminated before September next year. Instead he may argue that QE is correlated with the pick-up in data, and if the punch bowl was taken away too soon the economy could dip once again. Likewise, he may stress that the Eurozone is not performing evenly, so QE is thus justified for now. However, as you can see in figure 1, as the ECB’s balance sheet has expanded; this has helped to drag German CPI higher. If German CPI continues to move back into inflationary territory, then we could see pressure build from the Bundesbank to limit, or scale back, the QE programme in the coming months.
The market view:
European assets are in focus right now after bourses reached multiyear and, in some cases, fresh record highs last week. This coincided with a drop in the EUR, which has dropped more than 400 pips in the last 2 weeks. As we lead up to the ECB meeting we are seeing further EUR weakness and German 10-year bond yields are hovering close to 0%. If they fall to this level then it could encourage further EUR weakness and more stock market appreciation as investors’ hunt for yield.
If you trade EURUSD, watch the Dax:
Unsurprisingly, as you can see in figure 2, EURUSD and the German stock index, the Dax, have an inverse correlation. What is interesting, however, is that since the start of April this correlation has strengthened and is now -0.6. This is a significant inverse correlation, which means that when the EURUSD declines, the Dax index tends to rise 60% of the time. Since currencies have many different drivers, it is unusual for one factor, a stock index, to have a significant impact on a currency. We believe that the force driving this relationship is the ECB’s QE programme, and if Draghi continues to support QE on Wednesday then this relationship could have further to run, with potential further strength for the Dax, and a potential break of the critical 1.0458 support from 16th March for EURUSD.
Read our latest technical report for the EUR HERE: